Budget 2018: The fault in BJP’s stars

The Union Budget is usually about only a couple of key messages and expectations. This time, from a markets standpoint, there were only two —  the state of the fiscal deficit and Long Term Capital Gains (LTCG) tax on listed equities. On both the counts, the budget touches the left-extreme of the “Neutral” zone, ie, stopping just short of levels where markets would consider them as calamitous for asset prices. On the fisc though, it might have tipped just that little bit over further towards negative zone. To be completely fair though, the fault isn’t entirely within (the government), paraphrasing Mark Antony. A lot of it lies in the stars that we see!

A convenient explanation of the budget could be a typical election-eve “tax and spend” strategy. However, it isn’t so convenient. One, it isn’t all that clear as to the quantum of revenues the new LTCG would really bring in the next fiscal year, given that the base for taxing gains has been set at January 31, 2018. And besides LTCG, there isn’t anything material in terms of incremental taxation in the proposals. 

Basic direct tax structure remains the same, while indirect taxes are now governed by the GST regime, and hence out of the purview of the Union Budget. On the spending side, while fiscal deficit for FY2018 has been pegged at 3.5 per cent (against a target of 3.2 per cent), and for FY2019 at 3.3  per cent (against a stated goal of 3 per cent) — in the larger scheme of things, ordinarily it should not matter so much. At least from a credibility standpoint. In a year when GST and Demonetization created massive disruption, a 20 or 30 basis points (bps) slippage in fiscal deficit could be legitimately taken as a “one-off”. Especially for a government that has been pretty religious in adhering to stated fiscal targets (including in FY2014, when it inherited a target from its predecessor that was widely considered as unrealistic). 

The fact that the slippage in the fisc is fairly nominal by itself is a fairly brave statement of intent by the government – fiscal prudence extracts political costs, and attempting to do so in the home stretch to general elections, ordinarily, should burnish the fiscal credentials of the government. 

However, the issue isn’t limited to the fiscal deficit print. 

There is a constellation of stars coming together today that points towards a much higher level of interest rates in the months to come, more than simply some slippages in fiscal numbers. One, growth is on a cyclical upturn.

Aided by a global growth momentum, the economy is slated to grow much faster next year (the Economic Survey predicts a 0.25-0.75 per cent pickup in growth). Two, inflation is being squeezed in from all sides. Besides the sharp uptick in global crude oil prices, the budget also announced a new formula for Minimum Support Prices (MSP) for agricultural commodities, which is likely to result in faster growth in MSP. 

In effect, this reverses a key pillar of the inflation-management programme of the government, ie, a slow, calibrated growth in MSP. Three, rising global interest rates. In line with coordinated growth recovery around the world, especially in the US, global yields have been going up for some time, and are expected to continue. Putting all the above three together, there is only one conceivable place interest rates can go, and that is north. Policy rate hike by the Reserve Bank of India (RBI) would be a question of when and how many, and not if, during the course of the year. No wonder, bond yields spiked in the aftermath of the budget, with the benchmark 10 year Government bond going up by nearly 20 basis points.

From a macroeconomic standpoint, the biggest takeaway from this budget represents a reversal of the composition of spends. Overall expenditure is expected to rise by around 10 per cent, but there is a renewed skew towards subsidy heads of the budget. The sharpest increase has been on food subsidy, in line with the headline announcement of increasing MSP. Capital expenditure, on the other hand, has been shifted quite dramatically to “off-balance sheet” sources — essentially using cash flows and capital in government-funded institutions as equity to leverage up, raise debt-funding from capital markets, and invest into infrastructure. In theory, this is an efficient model of building infrastructure than a bank-funded private sector model that brought us much grief, especially in the last decade. 

There could also be the usual carping on whether the budget math is achievable. 

There are some fairly aggressive assumptions on revenue growth – in fact, if the tax numbers come true, it would represent the fastest growth that Modi government would have achieved in its tenure. A fairly large chunk of it is also a coin-toss — disinvestment and LTCG — accounting for nearly 1 lakh crore of budgeted revenues, both dependent on vagaries of the capital markets. There would also be the invariable questions on levels of funding of important announcements — especially the one on ModiCare that is being pitched as the piece de resistance by the political partisans. Enough to discuss, and enough to argue on the assumptions – but no less or no more than is generally true of Union Budgets. At the end of the day, governments over the years have displayed that there is enough slack in the system to meet numbers if they want to meet them. 

Union Budgets are scrutinised for vision, strategy and long-term impact. However, the macroeconomic long-term impact of Union Budgets are seldom very significant (1991-Manmohan Singh, 1997-P Chidambaram budgets are the exception rather than the rule). Issue is, the scope of the budget is rather more quotidian and often overtaken by events and developments during the course of the year. Markets tend to intuitively understand that. For this budget, the real takeaway, therefore, is a firm trend-reversal in interest rates — we are destined to confront high-interest rates in the foreseeable future. 

The author is Managing Partner of ASK Wealth Advisors. Views expressed are personal.